A nearly irrefutable law is the relationship between risk and return – higher potential returns cannot be pursued without accepting more risk, and risk cannot be avoided without accepting lower potential returns. In volatile markets and uncertain economic times, many investors would like to have some growth potential but are loath to lose principal. In a bit of investment alchemy, there is a type of investment product that strives to meet that elusive goal.

These products come in several flavors. “Structured notes” (notes) are obligations of the sponsoring investment firm. “Equity-indexed annuities” (EIAs) are issued and backed by insurance companies, while “index certificates of deposit” (CDs) are issued by banks with the principal (the amount invested) insured by the FDIC. They all, however, promise to pay an investor a return based on stock performance but return the original investment if stocks go down and they share some underlying terms.

Base index – Market indexes track the performance of an entire stock market or a specific segment of a stock market. Each index has its own rate of return and its own volatility, or degree of ups and downs. Some products define the base index while others allow the investor to select the index.

Guaranteed return – Notes and CDs typically guarantee the return of the principal amount if the investment is held until the maturity date, while EIAs guarantee slightly less than the principal amount but also pay a minimum annual interest rate. In all cases, the guarantees do not apply if the investor sells prior to maturity, and EIAs could involve surrender penalties and possible tax penalties.

Low interest rates and high index volatility have made it more difficult for notes to offer 100% principal protection. Some notes now cover losses only until the index falls below a certain level, at which point the investor suffers all the losses.

Holding period – Notes and CDs require that the investment be maintained for a specified number of years, or all bets are off. While EIAs may not have a required holding period, surrender charges and lower guarantees encourage investors to hold on for longer periods. Exiting early could mean penalties and fees as well as the impact of the index performance (and investors usually exit in times of market panic). Investors should not even consider these products unless they are reasonably certain the money can be tied up for years.

Participation rate – This rate determines how much of the gain of the index is credited to the investor. For example, a participation rate of 80% means that the investor will be credited with 80% of the gain of the index.

Caps or ceilings – Some products have a cap, or upper limit, on the investor’s return regardless of the participation rate or the index gain. These caps are often 7% to 10% for each year, and in some cases the cap extend over multiple years, say, 15% for any two consecutive years.

Return formula – The return formula, or how the changes in the index are determined over the life of the investment, is the real key to these products. In combination with caps and participation rates, they can dramatically affect an investor’s return.

Point-to-point: This method compares the index at two discrete points in time, usually the beginning and end of the investment holding period. This method can be great in a steadily rising market but can reduce gains in a volatile market or if the index declines towards the maturity date, regardless of prior gains.

Averaging: The index’s average value (daily or monthly) is used rather than the actual values on specified dates. Averaging may reduce returns in a bull market but can be helpful if the index has repeated ups and downs.

Annual reset: With either point-to-point or averaging, the change in the index may be calculated at the end of each year, gains are credited, declines are ignored and the index level is reset for the next year. This method “locks in” gains and can prevent bad years from wiping out prior gains.

High water mark: This feature can also be used with either point-to-point or averaging. The index is valued at each annual anniversary date and at the end of the investment the gain will be based on the highest annual level of the index. A high water mark can result in higher gains than other methods and protect against index declines.

In addition to these terms, the usual important factors such as expenses, potential changes in the contract and the stability of the guarantor (the insurance company or investment firm) should be considered. Little wonder that the Financial Industry Regulatory Authority (FINRA, the independent regulator for all securities firms in the US) has issued an investor alert on equity-indexed annuities. As FINRA notes n the alert, “Although one insurance company at one time included the word “simple” in the name of its product, EIAs are anything but easy to understand. Because of the variety and complexity of the methods used to credit interest, investors will find it difficult to compare one EIA to another.” And most investors who are capable of evaluating these products can achieve similar results through a combination of a diversified portfolio, options and other investment techniques, while retaining much greater flexibility and control.

Still, these products can be attractive for investors who are willing to give up much of the potential stock market return in exchange for some principal protection and higher returns than are available from other interest-based investments. It’s best to heed FINRA’s advice and before buying one of these products, “you should understand the various features of this investment and be prepared to ask your insurance agent, broker, financial planner or other financial professional lots of questions” about whether it is right for you.